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The Top in the Japanese Government Bond

02/19/02 01:56:56 PM
by David Penn

The recent pullback in the JGB affords another opportunity for bears to get on board for another leg down.

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Position:   N/A

The "Short Japan" crowd, which likely has been paying the bills with well-timed sells of the Japanese yen and Nikkei stock market for nearly a decade, recently smelled new blood in the Japanese bond market--particularly with regard to Japanese government bonds or JGBs. I will not go into the various fundamental reasons why bears that have been sharpening their claws on Japanese financial markets are looking to finish off the job with an attack on JGBs. However, suffice it to say that interest rates in Japan have been moving down for so long in an attempt to "undercut" deflation, that many are beginning to believe that an attempt at "reinflating" the Japanese economy may be the next approach--an approach that would mean higher interest rates in the immediate term ... and lower bond prices.

Looking at a chart of the continuous Japanese government bond contract (JGBs are traded on the LIFFE, which stands for London International Finance and Futures Exchange), two things are immediately apparent. The first is the major bull market in JGBs that lasted from September 2000 to the spring of 2001. This six month advance, incidentally, was only the most recent leg of a bull market in Japanese government bonds that has been going on almost without pause since 1990 (the most significant correction was an 8% drop in 1994). The second most apparent feature of the JGB chart provided is the year long top; in fact, this top almost literally begins in January 2001 and looks to have ended in January 2002.

An unsuccessful test of resistance could set up a reversal and subsequent decline to the 2001 lows.
Graphic provided by: MetaStock.
The JGB has already started to break down. Off a little over 3% from its peak at 141, the JGB fell beneath support at 137.5 in December 2001. This support level corresponds with the 2001 low--which also represents an initial bear market confirmation point (i.e. the trough of the last major correction in the previous bull market). The breakdown ended at the end of January, when prices hit 135.5, and the JGB has been in a rally mode in February. The question is whether or not the JGB will successfully test the support-turned-resistance area of 137.5.

Waiting for this test might be the best approach to the Japanese government bond. The JGB is only a few points above the breakdown target low of 134, which also corresponds with a support level from the November 2000 correction. If a new bear market in the JGB is in fact underway, then the current test rally will need to fail around 137, providing another entry point for short-sellers and a little more downside room.

Having written about intermarket technical analysis in general and the leading nature of bonds vis-a-vis stocks elsewhere, I should probably clear up any confusion about the relationship between the Japanese bond market and the Japanese stock market. Generally speaking, bond prices lead stock prices. However, Japanese bond prices have been rising while the Nikkei has been in decline. This apparent contradiction to the usual tendency of bond prices leading stock prices is explained by something called Gibson's Paradox. While originally developed as part of the theory behind the gold standard, Gibson's Paradox nevertheless suggests that in deflationary environments, the ordinary relationship between bond prices and stock prices is inverted. In a deflation, such as the one Japan has been in for a decade, stock prices generally follow bond yields and not bond prices, as is generally the case.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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